Taxes and refunds

[Bcp1984]

So I have a little dilemma going at the moment, or probally not as much of one as I think.

I owe taxes this year, big time (1700 state ad federal) this was due to wrong taxes being taken out of my wifes pay. I know we should have caught it, but its over with now, and she doesnt work there anymore so it wont be an issue going forward.

I ran a scenario in which i deposited 10k into IRA's for my wife and myself outof our savings. What I found is that i went from owing $1700 to recieving $700 dollars. Perhaps I am looking at this incorrectly, but in my mind i have an unrealized gain of $2400 if i go this route (1700 not owed plus 700 refund= 2400)

Or I can just pay the $1700 in taxes and press. I know this is likely a stupid question, but welcome your thoughts and suggestions on whether I should make this move, not only for just our taxes, but for our retirement as well. I keep beating myself up about taking 10k out of the house fund, contributing to an IRA and not being able to use it for 33 more years.

[jpg7n16]

Well it's not really an unrealized gain. It's more of a postponing of the taxes.

If you're in the 25% bracket, each $10k of additional income costs you $2500 in taxes. So if you contribute to a deductible IRA, you get to deduct $10k of income, so your tax bill shrinks by $2500 today. You'd then be taxed when you withdraw.

So it's not really a gain, just a deferral. You may pay it eventually.

Are you contributing to a retirement plan regularly?


It really seems like the house fund goal is much more important to you than the retirement savings. So I'd likely advise you to pay the $1700 in taxes today, in order to meet your top goal faster.

Though I'd caution that you need to be saving for retirement eventaully (if not already). And the longer you put it off, the harder it is to do.

[MonkeyMama]

If you don't want to put it to retirement, you'd be better off paying $1700 in taxes than $10k to retirement. Simple as that.

Yes, you would save $2400 taxes now, but you would have to pay the taxes when you withdrew the money in retirement.

[Money Gal]

I would put enough into IRAs to zero out the tax liability.
Did you do any charitable giving that would reduce liability? Food or Clothing Drive donations that you might have forgotten about?
Do you have children & any child credits? What about energy efficiency or HCTC credits you might be eligible for?

[Bcp1984]

The IRA would not be taxable since I am putting it in a traditional IRA with money that has already been taxed? Is this not correct? I already contribute 20 percent of my base pay to TSP (about 500) monthly. My concern is giving the government my money and having to pay taxes because I dont invest in an IRA. If I invest 10k I am really only investing $7600 because I dont have to pay 1700 in taxes AND get 700 to kick start the savings back to 10k that I moved to IRA.

Is this an improper way of thinking?

Brandon

[jpg7n16]

The IRA would not be taxable since I am putting it in a traditional IRA with money that has already been taxed? Is this not correct?

Well I like your thought process

But by contributing to a deductible IRA, you take post-tax money, and turn it back into pre-tax money.

If it is not a deductible IRA (like a Roth, or a non-deductible traditional IRA) then there is no effect on your taxes today. And then your money would remain post-tax, so you would only be taxed on growth (or if Roth, you're not taxed on anything!)

So the only way that you get to avoid paying that $1700 in taxes is by turning your post-tax money into pre-tax money.

I already contribute 20 percent of my base pay to TSP (about 500) monthly.

If you're already contributing 20% of your income, and saving for a home is one of your top priorities, I'd definitely recommend paying the taxes to keep that money out of the retirement account. You're already doing great by saving 20%.

My concern is giving the government my money and having to pay taxes because I dont invest in an IRA. If I invest 10k I am really only investing $7600 because I dont have to pay 1700 in taxes AND get 700 to kick start the savings back to 10k that I moved to IRA.

Is this an improper way of thinking?

Brandon

Kind of. If you invest $10k, you can only get $2400 knocked off your taxes by deducting your contribution (turning it to pre-tax money). If you do that, then you won't be taxed today, but you will be taxed when withdrawn.

And you'd also set your housing fund back to the tune of $10k.

[Slug]

Couldn't you put in a traditional IRA in 2010, then convert that to a Roth in 2011. You'd pay taxes on the conversion in 2011, but that's essentially a deferral to April 2012 of today's tax liability. The thing I don't know is if you converted to the Roth, can you still withdraw contributions without penalty for a home purchase? Anybody?

[MonkeyMama]

The IRA would not be taxable since I am putting it in a traditional IRA with money that has already been taxed? Is this not correct? I already contribute 20 percent of my base pay to TSP (about 500) monthly. My concern is giving the government my money and having to pay taxes because I dont invest in an IRA. If I invest 10k I am really only investing $7600 because I dont have to pay 1700 in taxes AND get 700 to kick start the savings back to 10k that I moved to IRA.

Is this an improper way of thinking?

Brandon

So the question is would you rather pay taxes or would you rather have savings for a house? This is really the only question.

If you contribute $10k to your IRAs, you will save $2400 in taxes. But, you will lose $10k from your savings fund. If you pay the taxes, you only lose $1700 from your savings fund.

It's not an either/or proposition as others have suggested. You could put just enough in your IRAs to get to a $0 tax liability. Maybe a compromise in the middle is best for your situation. A $7k IRA contribution may wipe out any taxes due, based on the details you have given.

As others said - if you put the money into the IRA, you get the tax deduction now, which means the IRA is just taxed later (upon withdrawal).

[jpg7n16]

Couldn't you put in a traditional IRA in 2010, then convert that to a Roth in 2011. You'd pay taxes on the conversion in 2011, but that's essentially a deferral to April 2012 of today's tax liability. The thing I don't know is if you converted to the Roth, can you still withdraw contributions without penalty for a home purchase? Anybody?

While that's true, it doesn't really solve the problem. You'd just postpone the taxes 1 year, and then be in the same predicament next year. Because OP could come back and post about how he did this conversion from a traditional to a Roth IRA and it's creating an extra $2400 tax liability. Should he recharacterize the conversion and undo it to avoid paying the taxes? Or just pay those taxes from his housing savings? He'd be in the same spot, just 1 year later.

This 'solution' is from paying taxes this year, to paying taxes next year. Either way, you wind up paying the taxes.

So since the money will ultimately go to a home purchase anyways, why go through all that hassle? Just pay taxes out of cash this year.

You can always withdraw your cash without penalty for a home purchase too.

-----------------------------------------

OP has two conflicting goals:

1. Save for retirement
2. Save for downpayment

So, I would only recommend that OP put money into retirement savings if he were far behind on retirement. But since OP is saving 20% of income already, he is already making progress towards achieving both goals.

Converting to a retirement account wouldn't make up for lost time, or be for a current year deficiency, it would just be extra above what's necessary. And in order to do that, he'd significantly impair his housing fund.

Small upside for his retirement, but big downside for the housing fund.